This post will almost certainly be out of date by the time notice of it arrives in your inbox. That’s because the current volatility in the market is extraordinary. It’s not uncommon to see a 1% swing in as little as five minutes. After quietly and systematically marching to a succession of new highs in January and through February 19, the index has slipped into a highly indecisive phase.

After the 14.9% week-long drubbing from the close of business on Friday, February 21 through the low on Friday, February 28, the weekend brought a mixture of news. Despite low expectations, the Chinese manufacturing PMI (purchasing managers’ index) came in below projections. It registered just 40.3 versus 45.7 consensus. Anything below 50 is a contraction. The non-manufacturing PMI, however, seemingly dissolved under the acidic assault of the coronavirus (COVID-19); it was 29.6.

On a presumably positive note, it was rumored that the Fed and other central banks around the world were about to open the monetary spigots again in response to the negative economic effects of COVID-19. Specifically, the Fed funds futures market expected a 50-basis-points cut. The Bank of Japan met expectations on Monday, March 2. On Tuesday, the Fed joined the fray, cutting half a percentage point, the first action of this kind since 2007.

Unfortunately, markets took little solace in fighting a biological menace with interest on fiat currency. In the current environment, the virus translates into both a demand shock and a supply shock—a sickness whose remedy requires more than lower rates. At the end of trading Tuesday, the markets had erased most of Monday’s gains, ending well below the 200-day moving average and awaiting whatever drama would develop by Wednesday morning.

The Specter of 2008

Economist David Rosenberg has warned against enthusiasm over the massive upward move on Monday by those admonishing investors to persistently “buy the dip.”

As the bulls go wild on today’s bounce, a reminder: we had 11 sessions in the 2008/09 bear market when the Dow surged 4%; and 7 of these same whippy moves in the 2001/02 malaise. These happen more in bear markets than in bull markets by a huge margin.

Indeed, the first 4% surge in 2008 was after the completion of the first 10% selloff from the market peak over the six months stretching from October 2007 through March 2008.

Figure 1: SPX March 2007 – February 2009 (top), daily index change (bottom)

Over the next three months, a subsequent rally retraced some 50% of the ground lost. In reality, the economic landscape continued to deteriorate during that time, and larger drops were just over the horizon.

A moral of this story is that large, volatile spikes higher are the hallmark of bear markets. Bull markets tend to grind, rather than catapult, upward.

The key difference now is that what took nine months in 2008 took nine days in 2020. Technology really does speed up market behavior. This is trading in the Twitter age. The difficulty for investors, though, is avoiding extrapolation. Just because the more recent movement was so rapid doesn’t necessarily mean subsequent moves will be similarly compressed.

The Fed’s action on Tuesday also recalls the 2008 crisis. That episode was the last in which the Fed made an intermeeting emergency cut to the Fed funds rate. It was also 50 basis points in August 2007. The Fed tried the same maneuver in January 2001. In both cases, the markets rallied hard following the announcements, but the policy changes ultimately didn’t rescue investors from the inevitable declines in valuation in the wake of systemic economic weakness.

Biology in a Techno Age

Markets have genuine cause for concern. Regardless of how lethal the COVID-19 proves to be, its economic impacts will be profound. Some have cited the relatively muted impact of the 1918 Spanish flu on equity markets. The S&P 500 dropped somewhere around 25% during the pandemic. The comparison is so inadequate, however, as to be ludicrous. First, in 1918 the world was already experiencing various economic shocks associated with World War I. Further, and more importantly, the average CAPE (cyclically adjusted price-to-earnings) ratio in 1918 was about 6.5 rather than north of 30 today. Finally, the world was far less interconnected a century ago. What happened in China then did not impact the U.S. within the 12 hours it takes for a transpacific flight to complete its journey.

We will not reiterate the theory of the black swan here but say simply that the current epidemic applies in spades. The United States seems especially ill-prepared for this particular landing.[1] The Centers for Disease Control and federal response authorities are clearly in disarray.

Compared with the South Koreans, a context our firm understands especially well, the United States stands dangerously close to a civilian crisis of confidence. Given our reliance on consumer spending, investors should proceed with caution. This is true for both health and wealth. Regarding the latter, our personal preference in such unstable and overvalued markets is to mostly hold cash. The exception is small positions long volatility in instruments that benefit from fear and investors offloading risk. Market panics are pandemics in their own right for which preparation is essential. That is advice that never expires.


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